There are many legal and tax implications to know if you’re part of a business, especially when it comes to member payments. An important aspect of multi-owner limited liability company (LLC) agreements is whether its partners can receive LLC guaranteed payments — or other types of income — from the business as a salary.
Those with multiple owners can be treated as partnerships by the Internal Revenue Service (IRS), for example, meaning that business income is passed through to owners. These owners then pay taxes on that income on their own personal tax returns, which impacts the total amounts they claim, their tax bracket, and more. This guide will walk you through everything you need to know about LLC guaranteed payments, including exactly what these payments are and who can benefit from them.
What Are LLC Guaranteed Payments?
Guaranteed payments are distributions made to partners or owners within the LLC. These payments allow them to receive a set amount of compensation for the work they do for the business. Such sums are not impacted by the LLC’s profits, which is why they are considered “guaranteed.”
Guaranteed payments are reported on IRS Form 1065, U.S. Return of Partnership Income, which reports all income, deductions, losses, and more from partnership operation. All income the LLC makes is passed through to the members when it’s taxed as a partnership, though, which makes understanding who qualifies for such payments crucial to business success.
Who Receives LLC Guaranteed Payments?
An LLC differs from a traditional partnership in that the LLC members aren’t liable for the business’s debts. In a partnership, the partners are liable. Multi-owner LLCs can still be treated as partnerships for income tax purposes, however.
Any LLC member can receive guaranteed payments if these payments are included as part of the LLC’s operating agreement. LLC member payments can be made in several forms, and it is beneficial to compare them against the guaranteed payment method:
- Draws
LLC draws aren’t usually guaranteed, but they can be made to members at any time and are essentially an advance on estimated LLC profits.
- Distributions
LLC Distributions are made at the end of the year and represent a percentage or share of the LLC’s profits.
- Guaranteed Payments
These payments are guaranteed and are not impacted by whether the LLC makes a profit. Guaranteed payments ensure that a partner gets a set amount of money at an agreed-upon frequency.
While there are benefits to each type of payment method in an LLC, guaranteed payments provide additional reliability and security for members that the others can’t. This is one of the biggest benefits of guaranteed payments, but there are other upsides to consider, as well.
4 Tax Benefits of LLC Guaranteed Payments
So, should you set up guaranteed payments in your LLC agreement? What are the key tax benefits of doing so for both the LLC and its members? Here are the top four benefits to evaluate against other payment types.
1. No Income or FICA Takes Taken by the LLC
An LLC isn’t required to take out income tax or FICA tax from member’s guaranteed payments. Those proceeds are still subject to self-employment and estimated income tax that must be paid by each member receiving a guaranteed payment, though.
2. Guaranteed Payments Are Tax-Deductible Expenses
The LLC can deduct guaranteed payments as expenses, lowering the business’s overall tax burden.
3. Payments Are Made With or Without LLC Profit
These payments provide members a steady income they can rely on since they’re not dependent on whether the LLC makes a profit. Partners get to plan around a set minimum compensation amount, like a salary.
4. Guaranteed Payments Help Eliminate Partner Risk
They eliminate the risk of a member making significant contributions to the LLC and not receiving compensation for their time or efforts. Guaranteed payments can be a successful, tax-efficient way to compensate LLC members with a reliable income, plus give such business ventures more predictable operating expenses.
4 Common Mistakes Relating to LLC Guaranteed Payments
Any business venture has its ups and downs, and even minor mistakes can mean a huge impact on the bottom line. There are a few important points to remember when coordinating guaranteed payments that will help you and the LLC avoid common mistakes.
1. Personal Tax Impact
Make sure payments are timed correctly, so members don’t have significantly increased tax burdens on their individual returns.
2. Formalize Payment Terms
Terms regarding guaranteed payments should be clearly outlined in the LLC’s operating agreement to avoid confusion down the road and ensure the payments can be made. Make sure that all terms and payment structures are clearly stated in writing.
3. Loss of Pass-Through Entity Status
If the LLC chooses to be taxed as a corporation, it will no longer be a pass-through entity. The LLC must be treated as a partnership for tax purposes by the IRS to receive guaranteed payments.
4. Estimated Income Tax Burden
Individual members have to make estimated tax payments on this income each quarter. While guaranteed payments have many benefits, remember that the LLC could face legal or financial issues without the right strategy in place. That’s why it’s always wise to sit down with professionals to go over your options and approach.
Get Help with Your LLC From a Tax Professional
Individuals who are part of multi-owner LLCs need to make sure they fully understand all the tax implications of draws, distributions, and guaranteed payments. While there are pros and cons to each structure, guaranteed payments are part of many LLC contracts so members can rely on a steady income for the time and energy they put into the business. Just make sure you understand how this income must be taxed at the individual level and include all necessary information in the agreement.
Reach out to Silver Tax Group to speak to a tax expert about LLC guaranteed payments or other questions you may have about the LLC tax process. We’re ready to help you make the most of your multi-owner LLC.
